This paper provides a concise overview of interest rates, tracing their origins from the historical concept of usury condemned by the church to their modern role as a fundamental mechanism of economic life. It explains how interest rates function as the cost of borrowing money and examines how the Federal Reserve uses rate adjustments to stimulate or restrain economic activity. The paper also explores the particular sensitivity of the auto industry to interest rate fluctuations, noting that rising rates and oil prices in the mid-2000s threatened to curtail consumer demand for large, expensive vehicles such as SUVs and luxury cars.
One might think of interest rates as merely a concern of cutting-edge modern economic news. Indeed, the rate of interest has been the obsession of the business media in recent years. A March 21, 2005 Business Week article proclaimed, "Pop! Goes the Auto Bubble — with oil prices and interest rates rising!" (Mandel, 2005). In actual fact, however, interest rates are simply the percentage at which an individual is charged for borrowing money, whether from a bank, another person, or an entity such as a credit card company. Interest rates are an old institution — once, the rate of interest was called "usury" and banned by the church. Today, charging a reasonable rate of interest for borrowing money is considered a necessary fact of modern life, particularly for large, durable goods such as cars, houses, and appliances.
Unsurprisingly, the lower the rate of interest — that is, the less one is charged for borrowing money — the more attractive it becomes to borrow and spend money that one does not technically have in hand. The higher the rate of interest, the less likely one is to borrow and spend. Consumer behavior, therefore, shifts predictably in response to rate changes: low rates encourage spending, while high rates encourage saving. This dynamic gives policymakers a powerful lever for influencing economic activity.
"Fed uses rates to stimulate or cool the economy"
"Rising rates threaten auto sales and SUV demand"
Always verify citation format against your institution’s current style guide requirements.